In matters of Real Estate, an appraisal is an unbiased professional opinion of the value of a home and is used whenever a mortgage is involved in the buying, refinancing, or selling of that property.
There are many reasons why it is important to ascertain an objective valuation for a property but basically there are only three (3) accepted methods used in the industry for this purpose.
The Sales Comparison Approach -
Replacement Cost Approach -
The Sales Comparison Approach is used most often by Real Estate Professionals for the purpose of determining the value for the following:
Determining Value for the Purpose of Selling a Property
Obtaining approval for financing from a Mortgage Lender either for re-financing existing liens or originating a new loan to provide purchase money financing.
Determination of Value for purposes of Taxation
Determination of Value for the division of Assets (Divorce or Selling a Percentage of a Property owner’s Share of an Asset)
Liquidation of Assets in an Estate.
In this method, the data is used based on the most comparable recent sales, starting with those in closest proximity, age, style, features, and similarity to the subject property. Then adjustments are made to the comparable properties for any deviation that these homes may have had from the subject property.
For homes that were superior a reduction of value is made and for homes that were considered inferior, an addition to value is made. See the Attached Uniform Residential Appraisal Form
The accuracy of this method relies heavily on finding a property that is MOST comparable therefore it is not an acceptable practice to use homes that require very large adjustments in either direction. Examples of this include comparing single story versus two-story, homes with pools or outbuildings versus having none, and/or gross size differences. To be most accurate a professional appraiser will therefore always seek the most similar property for use when doing their analysis starting with those closest in area, date of sale, and similarity and only work outward to the extent that properties can be found which most clearly demonstrate an apples to apples comparison or like-kind evaluation …
The Replacement Cost Approach is generally used most often in the evaluation of New Construction and for the purpose of loss mitigation due to insurance claims. In this approach, the evaluation is made by taking the land value and estimating the cost of rebuilding the structure given current materials and labor costs to rebuild.
The Income Approach is formulated by taking a capitalization rate or most often use of what is called a gross rent multiplier (GRM) and applying it to the market rent for a property to determine value. The GRM for any property can be determined by taking the value of the property and dividing by the Gross Rents (GRM = Property Value / Gross Rental Income) so for example, if a home valued at $250,000 received $24,000 in yearly rental income it would have a GRM of 10.41. Using the average GRM in an area against known values of rents collected would allow for the estimation of the value of a similar property. For Example, a home receiving $18,000 in yearly gross rents with a GRM of 10.41 would indicate a value to be at $187,380.